Choosing When to File Bankruptcy: What to Consider

Choosing When to File Bankruptcy: What to Consider

by Edward A. Haman, Esq., March 2015

Not everyone with debt problems needs to (or should) file for bankruptcy. If you are asking yourself, “Should I file bankruptcy?” and you answer “yes,” one of the next questions would be when to file bankruptcy. It may be an advantage to file as soon as possible, or it may be an advantage to wait some time.

In analyzing whether filing bankruptcy is right for you, it is necessary to understand the types of bankruptcy. The Bankruptcy Code has several “chapters,” some of which apply to individuals and some to businesses. The two chapters that apply to most individuals are Chapter 7 and Chapter 13. To put it simply, Chapter 7 results in the forgiveness of debts, and Chapter 13 results in establishing a plan to pay at least a portion of debts (and forgiveness of the rest). Which chapter you use will depend upon the extent of your debts and your financial ability to make payments.

Analyzing Your Situation

A good place to start is to make a list of what you owe, and what income or assets you have available to pay those debts. Debts are divided into secured debts and unsecured debts. Secured debts are those attached to specific items of property, like a mortgage or car loan. If you fail to pay, the creditor may take the item of property securing the loan. Unsecured debts are not attached to any particular property, such as debts for credit cards and medical bills.

Certain types of property are exempt from the claims of creditors. Exactly which type of property is exempt will depend upon your state of residence. (See Which Exemptions Can You Use In Bankruptcy?) Also, bankruptcy generally will not allow you to eliminate debts for taxes, student loans, child support or alimony.

Chapter 7 or Chapter 13?

A bankruptcy filed under Chapter 7 will use your nonexempt property to (at least partially) pay your creditors. You will be entitled to keep your exempt property, and will have any remaining debt wiped out. Chapter 7 is a good choice if you have a lot of unsecured debt, few nonexempt assets, and little or no income. However, even if your home and car are exempt, you may still lose them if you don’t keep up the mortgage and car payments.

In a bankruptcy filed under Chapter 13, you establish a new payment plan for your debts—something that you can manage on your income. Chapter 13 is often a good choice if you have more than enough income to cover basic living expenses, want to avoid foreclosure on your home or repossession of your vehicle, and need the new payment arrangement to catch up on paying your debts. This is frequently used by people who are currently employed, but who incurred excessive debt due to temporary financial problems caused by such things as divorce, a job layoff, or serious medical expenses. If you meet certain income requirements, you will not be able to file under Chapter 7, but will be required to use Chapter 13.

Reasons Not to File Bankruptcy

Filing for bankruptcy will destroy your credit score. A Chapter 7 bankruptcy will be on your credit report for 10 years. A Chapter 13 bankruptcy will be on your report for 7 years. In addition to being denied credit for the next decade, a bankruptcy on your credit report may be used to justify being turned down for a job, paying higher insurance rates, being denied renting an apartment or house, and having to pay higher security deposits for such things as rentals and utility services.

If you have income that may be sufficient to allow you pay your debts at a reduced monthly amount (over a longer period of time), you may want to first look at alternatives, such as credit counseling services, debt consolidation, or trying to negotiate with your creditors to modify the terms of the loans. However, you have to be careful with debt consolidation, as this frequently turns unsecured debt into secure debt, which will make things worse if you end up filing for bankruptcy. Also, if you go through some type of debt adjustment, and end up having to file for bankruptcy anyway, you will have paid money needlessly.

Short-Term Considerations

When to file for bankruptcy is another question. If you are expecting an income tax refund, you may want to wait until you receive it so you can use it to pay for the bankruptcy filing fee or for a bankruptcy attorney. Some people file near the end of the month, since you are required to produce pay stubs for the past 60 days. You should pay your necessary bills before filing (mortgage or rent, car payment, food, utilities, etc.), so that your bank account balances are at their lowest. Whatever money is in a bank account on the date of filing can be used by the bankruptcy court to pay your creditors. You want to be sure the checks clear before filing. One way to avoid a problem is to pay your bills with a cashier’s check or money order just before filing.

Reasons to File Bankruptcy Now

One of the main immediate benefits of filing for bankruptcy is called the automatic stay. This means that once your creditors are notified of your bankruptcy filing, they must stop trying to collect the debt. They may not call you, mail any collection letters, pursue a lawsuit, garnish your wages, try to seize your bank accounts or other property, or shut off utilities. However, if you have a mortgage, the mortgage holder may ask the court to lift the stay so it can proceed with foreclosure, but this will still take a little time and will at least delay the foreclosure some.

Good indications that it might be time to file include:

  1. You have been unemployed for an extended period, have no unemployment benefits, and have little or no savings. Generally, you are not able, or only barely able, to meet your basic living expenses. Nothing, or almost nothing, is left to use for paying debts.
  2. Your home is going into foreclosure. The main benefit here is that the automatic stay will temporarily stop the foreclosure. If you want to keep your home, in a Chapter 7 bankruptcy, you will need to be able to quickly catch up on your payments, or make some type of repayment agreement with the lender. If this is not possible, a Chapter 13 bankruptcy may allow you to establish restructured mortgage payments.
  3. Your landlord is seeking to evict you. The main benefit is that the automatic stay will temporarily stop the eviction process. However, once your landlord obtains a judgment for eviction, filing for bankruptcy will not help you.
  4. Your car is about to be repossessed. The automatic stay will temporarily stop the repossession. Ultimately, under Chapter 7, you will need to catch up and maintain payments to keep the vehicle. Chapter 13 may allow you to restructure the payments.
  5. Your wages are being garnished. The automatic stay will stop garnishment.
  6. You are being sued for delinquent debts. The automatic stay will stop the lawsuit.
  7. You are about to start, or recently started, a higher paying job. If you earn too much money, you will not be allowed to file under Chapter 7, but will need to use Chapter 13. For this determination, the court considers your average monthly income for the six-month period before filing. Each month you delay filing is another month of higher pay that will increase your average monthly income, and lower the chance that you will be able to file under Chapter 7.
  8. You are expecting to receive property in the near future. Generally, your financial situation for purposes of bankruptcy is your situation on the date of filing. If you acquire property, or incur debts, after the date of filing, they are generally not part of the bankruptcy process. Therefore, if you think you may soon be receiving an inheritance from a seriously ill relative, assets from a divorce or an employment bonus, you may want to file before you receive it. However, this is not quite so clear-cut, so qualified legal advice would be needed.
  9. You are moving to a state with less favorable exemptions. You must file for bankruptcy in the state where you are domiciled. Your domicile is your principal place of residence. You may be a part-time resident of more than one state, but you may only have one domicile state. This is typically the state where you have your driver’s license, where your car is registered, where you are registered to vote, and from where you file your tax return. If your former state has more favorable exemptions, and you have not yet changed your domicile, you may want to file for bankruptcy now in your “old” state where you are still technically domiciled.

Reasons to Delay Filing Bankruptcy

There are numerous situations in which a person may want to delay filing for bankruptcy. These situations include:

  1. You are about to start, or recently started, a lower paying job. If you earn too much money, you will not be allowed to file under Chapter 7, but will need to use Chapter 13. For this determination, the court considers your average monthly income for the six-month period before filing. Each month you delay filing is another month of lower pay that will decrease your average monthly income, and increase the chance that you will be able to file under Chapter 7.
  2. You are moving to a state with more favorable exemptions. If your new state has more favorable exemptions, you may want to delay filing until you have established the new state as your domicile.
  3. You are expecting more debt. Only debt that exists on the date of filing for bankruptcy is part of the bankruptcy process. Any debt you incur after filing is not part of your bankruptcy—so you will continue to owe it. So, if you are expecting more medical bills (maybe a baby is due soon), or major home or auto repair bills, it may be best to wait until after you incur such debt so that it may be included in your bankruptcy.
  4. You want time to maximize your exempt assets. [WARNING: If the court determines that you have taken any actions with the intent to defraud a creditor, your bankruptcy can be denied. Whether there is fraud is a fine line, and largely subject to the opinion of the judge involved.] The idea is to sell nonexempt assets and use the proceeds to purchase exempt assets (or use funds from a nonexempt account). You might also use such nonexempt funds to pay off a loan on an exempt asset (such as a motor vehicle) or to pay off a nondischargeable debt (such as a tax liability, a student loan or child support).  
  5. You’ve paid a debt to a relative. If you pay a debt to a family member in excess of $600 within one year of filing for bankruptcy, the court can require the funds be returned to be used for paying creditors. To avoid this, you would need to delay filing until at least one year after paying the debt to the family member.
  6. You sold property for less than its market value. If you’ve sold an asset of significant value for less than it is worth within two years of filing, there is a presumption that it was done to defraud creditors, and the court can require return of the property. To avoid this, delay filing for two years after the transfer.
  7. You acquired your home within the past 1,215 days. If this situation applies, you will only be allowed to claim a homestead exemption of $155,675. If your state allows a higher homestead exemption, you may want to delay filing until 1,215 days after the acquisition.
  8. You are filing under Chapter 13, acquired your motor vehicle within the past 910 days, and owe more than the vehicle is worth. Under Chapter 13, you may have the balance on a vehicle loan reduced to the current fair market value. (For example, if the loan balance is $10,000 and the market value is only $7,000, you can wipe out the $3,000 difference.) However, this may only be done if you file for bankruptcy at least 910 days after the vehicle was purchased. It would benefit you to delay filing until the 910 days have passed.  
  9. You anticipate a significant income tax refund. You may benefit by delaying filing until you receive your refund and can use it to pay for essential living expenses, purchase an exempt asset or pay a nondischargeable debt.
  10. You recently took a cash advance. You may not wipe out a debt if it was due to taking out a cash advance of more than $925 from a single creditor (most often on a credit card) within 70 days before filing. In this case, you should delay filing until the 70 days have passed.
  11. You recently purchased luxury goods. You may not wipe out a debt for the purchase of luxury goods of more than $650 from a single creditor within 90 days before filing. In this case, you should delay filing until the 90 days have passed.
  12. You have certain older income tax debts. To have an income tax debt discharged in a Chapter 7 bankruptcy, the following requirements must be met: (1) the tax return was due at least three years before filing; (2) you filed the tax return at least two years before filing; (3) the IRS has not assessed the debt or assessed it at least 240 days before filing (longer if IRS stopped collection due to an offer of compromise or a previous bankruptcy filing); and (4) you are not guilty of tax fraud or evasion. In such circumstances, a delay in filing until these requirements have been met would be advantageous.

While you may ask yourself, “When should I file bankruptcy?” there is no simple way to determine a best time to file bankruptcy. You will need to evaluate your situation carefully, weigh the alternatives, and determine the best time for you to file.

Get help determining when to file bankruptcy with a free bankruptcy evaluation from a participating law firm.